Blackstone Made Money on Credit-Default Swaps With This One Weird Trick

If you have any taste at all, the only thing you should want to read about today is Blackstone's credit derivative trade on Codere, so here you go.

The Blackstone Codere trade -- in which Blackstone Group LP bought credit-default swaps on troubled Spanish gaming company Codere SA, then agreed to roll a $100 million revolver for Codere on favorable terms in exchange for Codere agreeing to make an interest payment on some bonds two days late, thus creating a technical default and triggering the CDS, pocketing some gains for Blackstone at the expense of the CDS writers, without costing Codere anything -- is such a glorious pinnacle of financial achievement that of course someone had to make a television show about it. I would have preferred a prime-time miniseries, but what we got is a "Daily Show" segment, and that will have to do. Here it is.

The segment consists mostly of Samantha Bee going around to TV networks, newspapers and BuzzFeed and asking if they'd covered the Codere story and getting some variation on "no" for an answer. Except Bloomberg! Bloomberg News broke the story! No thanks to me of course, 1 but I will nonetheless choose to be filled with pride because I work at a financial media organization that covered a European credit derivatives trade that even BuzzFeed missed.

That said, "The Daily Show" is perhaps a bit harsh. Codere is a small company in a faraway land. This trade, while lovely, was smallish; Blackstone made something like 11 million to 14 million euros on its CDS payout. No widows or orphans were harmed: The only losers here were the people who wrote CDS to Blackstone. Those people were presumably sophisticated, well-informed traders at big banks, and if they are honest with themselves, their reaction to losing on this trade is envy and admiration and possibly tweaking future CDS documentation. 2

Really, the only reason to cover this story is its majestic beauty. Which is a great reason to cover it, don't get me wrong; it's just that aesthetic appreciation of clever derivatives trades is sort of a specialized niche. Certainly "The Daily Show" didn't muster much admiration and instead spent seven minutes criticizing everyone else for not covering the story. This is wrong. This trade is so lovely that the proper reaction is to love it and cherish it and hold it close to your heart, not to complain that nobody else does.

There's one other reason not to worry unduly about this trade, and I hesitate to bring it up, but: It's not really as bad as it looks. I mean, yes, it is very, very clever. It achieves the second-highest goal of any financial engineering, which is to create genuine value for both parties to a transaction (here, Blackstone and Codere) by taking that value from some third party who's not in the room. 3 So that is great. As Blackstone spins it:

We love Jon Stewart and he continues to be one of the funniest people on TV. But the somewhat boring truth is that we cooperated with Codere and its advisors to save it from bankruptcy or liquidation. We provided capital when no one else would, which allowed the Company to live and fight another day.

And they could provide that capital efficiently because they took some value from their CDS writers.

But you shouldn't overstate that value. The reason that Blackstone made money on its credit-default swaps is not just that they were triggered by this clever maneuver. Just triggering CDS is not a big deal, because CDS pay out based on the difference between the face value of a bond and its post-default trading value. If Berkshire Hathaway Inc. forgot to make a bond payment and remembered two days later, Berkshire CDS would trigger and there'd be an auction and people who own CDS would get paid. But they'd get paid, in round numbers, nothing: Berkshire Hathaway bonds would still be worth pretty much par, and so the CDS payment would be low. 4

Instead, Codere's bonds were worth 54.5 cents on the dollar in the CDS auction, so Blackstone got paid 45.5 points on its CDS, which is a lot. (Sometimes people use a stylized model that assumes 40 percent recovery on default, meaning that the 54.5 percent recovery here is much closer to a real, bankruptcy-esque default than it is to a technical, you-still-get-par default.) It got that money not just because of the missed interest payment, but also because Codere credit, after the technical default and Blackstone's loan extension to Codere, remained really risky. Codere's other bonds still trade in the mid- to high 50s.

And Blackstone is still a lender to Codere, taking that risk. 5

The credit-default swaps market is a way to express in terms of money the market's estimate of a company's chance of default -- real default, not missing a payment by two days -- in the future. Blackstone found a way to turn that expression in terms of money into money. One day it had a CDS contract with a mark-to-market value of 11 million euros or whatever; the next day it had 11 million euros. 6 One day the banks were taking risk on Codere's credit that had gone against them to the tune of 11 million euros; the next day they had no risk and 11 million fewer euros. The risk that they got rid of was still worth about 11 million euros. (It still is now, too. 7 )

There's some friction here -- with cheapest-to-deliver options, with different notional sizes, etc. -- but basically what Blackstone did was take some money from people who were betting on Codere credit without financing Codere, and give it to -- I almost said Codere, but no, ha ha, mostly Blackstone gave the money to Blackstone. But at least Blackstone is financing Codere. It took money from an abstract zero-sum derivatives bet and turned it into an actual loan to an actual company that actually needed the money. To run casinos and racetracks, but still. That seems like the sort of trade "The Daily Show" should be willing to get behind.

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  1. I mentioned it in a linkwrap a week later, so my conscience is clear. Also, though: Go read it if you haven't! It is amazing!

  2. None of the losers seem to be quoted in that Bloomberg News article; I suppose that, in addition to envy and admiration, embarrassment would be an appropriate emotion for them to feel. Some earnest bond-investor types are quoted as saying things like "This is totally irrational from the perspective of an investor who loans money to a company, buys the bonds or loans, and expects to get paid back," but all that means is that they need to change their perspective, man.

  3. The highest goal would be to create value for both sides without taking it from anyone else. That probably happens, sure.

  4. Ooh, that sentence is an exaggeration. I mean, it's a stylized fact, but it is not a true fact. Interest-rate moves mean that the cheapest-to-deliver Berkshire bond would be below par. Actually, I see a 4.3 of 2043 trading at around 90. So you could make 10 points on a technical default. Consider also CDS on the United States. These moves are due to rates, not credit, so it feels a bit like cheating, but there it is.

  5. And now without CDS! I guess. I mean, I guess they could have plowed their profits into buying more CDS, but then there'd be no profits. Negative profits -- per that Bloomberg News story, Blackstone had 25 million to 30 million euros of CDS notional, while it and Canyon Partners are the lenders on a 100 million euro loan.

  6. Really, the CDS was wider before the default than after. Here's the one-year:

    [imgviz image_id:iWwt.8fhJZWA]

  7. This, too, is an exaggeration; Blackstone's swaps seem to have been quite short-dated for maximum leverage, so you could imagine a Codere CDS with just a month to go looking less risky now. But you have to imagine the counterfactual: If Blackstone hadn't done this trade and rolled Codere's credit facility, the chances of an actual default by now presumably would have been higher.

To contact the author on this story:
Matthew S Levine at

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